India plans scrutiny of new portfolio investors from China, Hong Kong

File photo of students wearing masks of China's President Xi Jinping as others wave national flags of India and China, ahead of the informal summit with India’s Prime Minister Narendra Modi, at a school in Chennai, India, October 10, 2019. REUTERS

India has drafted rules proposing tighter scrutiny of new Foreign Portfolio Investors (FPIs) from China and Hong Kong, three government sources told Reuters, its latest effort to check foreign inflows during the coronavirus pandemic.

The discussions come weeks after India said it will screen all foreign direct investment (FDI) from countries with which it shares a land border, a move it said was aimed at staving off takeovers when asset prices are depressed during the coronavirus pandemic. The Chinese government described the policy as discriminatory.

FDIs are longer-term direct investments that typically provide control over a firm's management. But concerns had risen in the government the policy change could prompt Chinese investors to ramp up their investment in India as portfolio investors, purchasing company securities such as equities to gain control, officials in New Delhi said.

Two senior government sources said India could set up a body to scrutinise new FPI registrants from countries such as China, and the rules will also apply to Hong Kong, a special administrative region from where substantial Chinese investments are routed.

The officials said a draft proposal had been drafted in consultation with the trade ministry and the capital market regulator, the Securities and Exchange Board of India (SEBI) and was currently being reviewed by the federal finance ministry.

The finance ministry and the trade ministry declined comment, while SEBI did not immediately respond.

The two sources added New Delhi is also considering the possibility of mandating a so-called "security clearance" from India's home (interior) ministry for new FPI registrants from these nations.

"We are not saying that any investment would be stopped, we just want to add a layer of vetting to protect the value of our companies," said one official who has direct knowledge of the discussions.

A third government source said India was concerned about Chinese state-run companies buying stocks of Indian companies. The source added the FPI rules were likely to be similar to the recently announced FDI policy which didn't name China but applies to countries with which India shares a land border.

It was not immediately clear if the rules will extend to other countries and if existing registered FPIs will face such scrutiny. There are currently 111 registered FPIs from Hong Kong and 16 from China.

Foreign portfolio investors are among the biggest drivers of Indian financial markets. Data from the National Securities Depository showed net FPI inflows in 2019 stood at $18 billion.

Concerns around FPI investments had particularly risen in recent weeks after shareholding disclosures by Indian lender HDFC in April showed China's central bank had marginally increased its stake in the company.

Atul Pandey, a partner at Indian law firm Khaitan & Co, said government screening could hit new capital inflows from China and Hong Kong and delay investment plans.

"(This will) have an immense impact on investor sentiment," said Pandey, who advises several Chinese investors.

The FDI policy change has already spooked Chinese investors, many of whom have put their investment plans on hold as they await clarity, Reuters has reported.